I recently had an interesting conversation with a business owner on the topic of how to manage a business successfully. We concluded that all businesses are working towards further growth and that a primary management concern is growth strategy. So, to manage a business successfully, one must manage growth successfully. How is this accomplished, and what considerations should be made?
Neil Churchill has an amazing write-up titled “The Five Stages of Small Business Growth.” In it he discusses the characteristics of small business types and what to expect at each stage of development. He defines five stages of development: 1.Existence, 2.Survival, 3a. Success-Disengagement, 3b. Success-Growth, 4. Take-off, and 5. Resource Maturity.
As you can imagine, the concerns at each stage differ, and conflict can arise simply from people’s perspective of a company’s position. If a company is in stage 3a but a manager is under the impression that they are in stage 4, the decisions made could have negative ramifications. At the very least, having management on different pages will result in contention among management. So, the first thing that must be established is a defined company position. Secondly, the direction the company is headed must be agreed upon and communicated to all. Churchill’s framework is only one model, but it can be used as a starting point. If the industry you are in has a better model, use it.
An Example of Differing Management Directions
As my conversation with the business owner progressed, he explained to me how some of the management was inclined to seek slow growth strategies, while others wanted to be a bit more aggressive. As a TOC practitioner, I know there are assumptions pushing each view, and before I gave my thoughts I needed to thoroughly examine each perspective.
The company has been around for a while and is diversified into roughly 5 industry types. The positioning and market share in some of these industry types is more mature than in others. The trend has been that change does not arise until a good deal of “pain” is felt from not changing. In other words, until there is an instant return on investment, change won’t occur. For the mature segments of the company, this is not a problem, but for the younger branches striving for growth, this is quite the headache. Without an established presence in an industry, a younger business cannot afford to move at the pace of larger, pre-existing businesses. Can you see the dilemma?
Opportunity Cost vs. Over-Extension
Opportunity cost is the cost of an opportunity not taken. For example, say you had a dollar to invest and the choice of two investments: A or B. You invest in A, which returns 10%, while investment B returns 15%. The opportunity cost of A is the 5% gain that was not realized because B was not chosen. This dynamic shows up in managing growth in the area of resource utilization. A company can either step up their capacity before demand exceeds it or after the demand exceeds it.
Benefits of Stepping up Capacity Ahead of Demand
Knowing when to step up capacity allows a company to manage its resources appropriately so that its internal capacity is not exceeded by the demand of the market. The idea is that the opportunity cost associated with having less capacity than market demand is quite significant.
A retail example:
This season’s highly anticipated new Nike shoe is the best thing since sliced bread. It is all the rage and every shoe store needs to have some of these on their shelf. Mom & Pop Shoe Co. put in an early order for 100 pairs and eagerly await their arrival. These new shoes are so popular that if an early order wasn’t placed, there would be no chance of receiving them before the end of the season. The season comes and Mom & Pop sell out of the shoes in the first month. The season is 3 months long, which means that for 2 months Mom & Pop have to turn away potential customers looking for the new shoes. At first glance, one might consider it a victory to sell out of the stock so quickly, but the unrealized loss is the 2 months of sales that could have been if Mom & Pop had ordered more shoes. Demand has exceeded capacity, and the unrealized sales could be as much as 3 times the sales of the first month.
Benefits of Stepping up Capacity after Demand
On the other side of the coin, the amount of risk assumed by Mom & Pop Shoe Co. was less than what it would have been if they had decided to preorder more than 100 pairs of shoes. Had they known the demand was going to be so great, they could have extended themselves out a bit more, assumed a bit more risk, and ultimately reaped a greater reward. Over extending one’s self is a function of the available financial capital. A business with a good deal of reserves can extend themselves further than a company with fewer reserves. Most Mom & Pop shops don’t have much money behind them, so avoiding the risk often times takes precedence over greater potential gains.
Allowing the demand to “pull” on one’s resources may also be desirable for a company that is well-established and wants to maintain conservative growth. In other words, a large organization with the ability to extend themselves out a great deal may ultimately choose not to because the potential of larger gains at higher risk does not outweigh moderate gains at a lower risk.
So, given the above dilemma, which direction is best? The answer of course is a function of the organization.
Smaller businesses are advised to maintain as fast of a growth curve as possible without overtaxing their current resources and without assuming too much additional risk. This means working up to the point at which the business is around 70% of its total capacity. A small business doesn’t want to exceed this because they will begin to see a drop in their ability to deliver on time. One’s due date performance is critical and should never be compromised for the sake of quick profits. It is also prudent to maintain cash reserves so as to carry the company through the unavoidable market downturns.
Larger organizations with greater cash reserves and more resources have their choice on which course to take. As I mentioned earlier, they may choose to go with a slower curve because they don’t feel the additional risk is worth the potential reward. Or, it may be determined that a faster curve is ideal to pick up market share at a time when competitors may be hurting because of a downturn.
It is assumed that all companies pursue growth, but the question is how best to manage growth? I would love to hear your thoughts and experience with this dilemma. Leave a comment or shoot me an email.